What Is a Short Sale and How Does the Mortgage Forgiveness Debt Relief Act Potentially

What Is a Short Sale and How Does the Mortgage Forgiveness Debt Relief Act Potentially

Martha Cossey, Relationship Manager at Market Street Settlement Group Manchester, NH 03101

What is a short sale and how does the Mortgage Forgiveness Debt Relief Act potentially expiring effect a seller?

A short sale occurs when a property is sold for less than its remaining mortgage principal balance, and executed as a way for both the existing homeowner and mortgage lender to reduce their respective losses. A lender will consider a short sale typically, although not always, for situations of extreme financial hardship instead of proceeding with costly foreclosure.

Because short sale approval is at the discretion of the lender, short sales are not automatic. Homeowners must often prove the need for a short sale to their lender.

To prove your short sale worthiness to the bank, the homeowner will need to prove the house is not worth what is owed on it. They will also be asked to submit a “hardship letter” (preferably handwritten) which explains their financial situation that inhibits their ability to repay the loan. The homeowner will also need to provide full financial disclosure such as;

1)Original purchase contract with comparative market analysisfrom their Realtor supporting the fact that the offer isbased on market value;

2)A balance sheet of your household income and expenses;

3)Your asset statements and proof of income; and

4)Two years of federal tax returns.

The homeowner should be prepared that getting short sale approval from the lender can be a lengthy process. Note that the following situations will oftenprovide for a speedier short sale approval:

1) The home is marketable;
2) A second lien holder, if one exists, is amenable to short sale proceedings; and 3) A foreclosure is not scheduled within the next four months.

Should the homeowner get short sale approval, the benefit to him/her is the mortgage debt can be forgiven by the lender - meaning the lender will accept a payoff that is less than what is owned in order to release the lien from the property. Prior to 2007, the forgiveness of mortgage debt by IRS regulations generally was treated as taxable ordinary income. In the words of the IRS on “When you borrowed the money you were not required to include the loan proceeds in income because you had an obligation to repay the lender.When that obligation is subsequently forgiven, the amount you received as a loan proceeds is normally reportable as income because you no longer have anobligation to repay the lender.” The lender is usually required to report the amount of the canceled debt to you and the IRS on a Form 1099-C cancellation of debt.

Due to the economic conditions in 2007, the Mortgage Forgiveness Debt Relief Act was created. This Act established a temporary moratorium on the taxability of such mortgage debt that is forgiven, and thereby not identified as taxable income.

As an illustration, assume that a mortgage on a homeowner’ s property had an outstanding baclance of $500,000. Assume also that the property sells as a short sale or at foreclosure for $400,000 and the lender “forgives” the remaining outstanding balance of $100,000. In the absence of the Act, the “forgiven” $100,000 would be treated as ordinatry income to the homeowner. From the IRS’ perspective, this is equivalent to the lender giving the homeowner $100,000 gift to repay the outstanding balance. However, the Act established a temporary moratorium on the taxability of such a mortgage debt that is forgiven.

Currently the Mortgage Forgiveness Debt Relief Act is scheduled to expire on December 31, 2012, and if it is not extended as of January 1, 2013, any such forgiven mortgage debt will once again be treated as ordinary income to homeowners.

Should this Act expire, the tax consequences are potentially significant to homeowners interested in pursuing a short sale. Any homeowner that is currently involved in a short sale process or considering a short sale should consult their tax and legal professionals on how the expiration of this act will effect them personally.

This information has been provided by the Mortgage Bankers and Brokers Association of New Hampshire (MBBA-NH) in conjunction with the New Hampshire Union Leader. Any questions about the content should be directed to the MBBA-NH at 6 Garvins Falls Rd, Suite 106 Concord, NH 03301 e-mail at website mbba-nh.org. Article supplied by Martha Cossey at Market Street Settlement Group 70 Market Street Manchester, NH 03101